Companies Awash in Cash. And Debt

By Alen Mattich

Big corporates are awash in money. The market for junk bonds is booming. Equities have soared over the past few years. And developed economies are struggling to post positive growth.

Interestingly enough, all four facts are related.

Yes, companies are reluctant to reinvest their earnings and are instead hoarding their cash. But they’re also restructuring their capital.

Companies are taking advantage of exceedingly low interest rates to swap out of more expensive equity capital and to lengthen the maturity of their borrowings. For instance, high-yield corporate bond and syndicated leverage loan issuance is growing at a record pace, while short-term debt has fallen sharply from the pre-crisis peak years.

Andrew Smithers, a respected pension fund consultant, has argued that U.S. corporate buying has been the major support of the equity market. “Companies have become the sole buyers of shares,” he wrote last summer.

That’s changed slightly with a return of retail investors to the market recently, but companies have continued to support their shares by way of purchases. Indeed, companies “have been distributing much more than 100% of the cash they generate from operations to their shareholders, either through dividends or share buy-backs” since at least the mid-1990s, he argued. That buying has been supported by ever-rising levels of corporate leverage.

Companies are stuffed with debt. U.S. non-financial commercial paper outstanding has exceeded the highs notched up around the time of the financial crisis and has more than doubled since the 2009 lows (data via the Sober Look blog).

Ironically, some of the biggest buyers of this debt are other corporations that have vast piles of cash on their balance sheets–commercial paper makes up more than 11% of corporate cash assets, according to a Wall Street Journal report.

By the end of the third quarter, U.S. non-financial businesses had $1.8 trillion in deposits and currency, up from $1.5 trillion in 2007, according to the Federal Reserve.

Mark Carney, the incoming Bank of England governor, has called these piles of corporate cash dead capital and others like Paul Krugman blame corporate hoarding of cash for exacerbating the economic downturn.

But the cash piles, recycled into Treasury bonds and other companies’ corporate debt has helped to drive down yields and thus, theoretically, lowered the threshold above which companies generate a return on capital. And yet they’re still reluctant to invest in expanding production. Why?

That’s the trillion dollar question. It could be Keynes’ animal spirits are still too muted, or it might have something to do with liquidity traps. But it could also be because companies don’t see many investment opportunities that will be profitable in the long-term–say once interest rates start to normalize. This could be because the pace of innovation has slowed or because the structure of developed economies has changed–maybe because of widening wealth disparities.

If that’s the case, if innovation has slowed, easy monetary policy won’t solve the fundamental problem.

Comments (1 of 1)

Unintended consequences can kill you. The Fed's policy of fixing an over leveraged economy with ever more debt is not only not working but creating additional problems. The very low rates after the dot-com bust was the last straw in the governments affordable housing fiasco and we are still paying for that policy mistake. The ultimate and inevitable deleveraging process will now take many additional years with consequences and bubbles that we currently don't recognize but are surely out there. During deleveraging years, an economy tends to surge from crisis to crisis and the inflation avoiding exit strategy, at this point, is simply speculative rhetoric. Obama and Bernanke seem to be guaranteeing the secular nature of our economic plight.

Our monetary policy is wrong, as is out fiscal and regulatory policy. The only sure thing is the future crisis buying opportunity that will be created. Of course, we all have to survive that crisis first. Good thing all that interest I am earning in retirement will carry me through.

Thanks for reading The Source. We would like to direct you to MoneyBeat, the Wall Street Journal’s brand new global blog. MoneyBeat unites MarketBeat, The Source, Overheard and all the Deal Journal blogs, bringing together all the market, M&A, IPO and hedge-fund news from those blogs into a 24-hour hub for finance news. Check it out and let us know what you think at moneyblog@wsj.com.